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Carr and Wu’s (2020) framework in the oil ETF option market

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  • Jia, Xiaolan
  • Ruan, Xinfeng
  • Zhang, Jin E.

Abstract

This paper studies the information inferred from the Carr and Wu’s (2020) formula based on a new option pricing framework in the United States Oil Fund (USO) options. We first document the term structure and dynamics of the risk-neutral variance and covariance rates which lead to a “U”-shaped implied volatility smile with a positive curvature. We then investigate the return predictability of the innovations in the risk-neutral variance and covariance rates (DRNV and DRNC) and their term structures (TRNV and TRNC) and find that DRNC is a significant and robust predictor to forecast daily, weekly and monthly USO excess returns in both statistical and economic terms based on in-sample and out-of-sample tests.

Suggested Citation

  • Jia, Xiaolan & Ruan, Xinfeng & Zhang, Jin E., 2023. "Carr and Wu’s (2020) framework in the oil ETF option market," Journal of Commodity Markets, Elsevier, vol. 31(C).
    • Handle: RePEc:eee:jocoma:v:31:y:2023:i:c:s2405851323000247
    DOI: 10.1016/j.jcomm.2023.100334
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    More about this item

    Keywords

    Crude oil; Risk-neutral covariance; Implied volatility smile; Return predictability; Option pricing;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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